How much house can you afford?
It depends on spending habits and the local cost of living.
This post comes from partner blog Blueprint for Financial Prosperity.
than one reader has e-mailed me in the last month asking how much house
I thought they could afford in our sinking housing market.
reader, Chester (not his real name), lives in California, where home
prices still seem in the stratosphere despite lowered prices. The
other, Wilson (also not his real name), lives in the Washington, D.C.,
region, where demand has kept home prices relatively stable.
both cases, I think the question of how much house you can afford is
independent of the local real estate market and more a product of your
spending habits and the local cost of living.
25% to 33% rule of thumb
wisdom says you shouldn't spend more than a quarter to a third of your
before-tax salary on housing. If your annual salary is $50,000, then
you'll want to have a monthly payment between $1,042 and $1,375.
Remember to include property taxes, homeowners association fees, condo fees, homeowners insurance, and other recurring monthly costs in that payment to calculate how much home you can afford.
How do you work backward to calculate the total price of the house? There may be a better way, but I played around with some numbers in DinkyTown.net's Mortgage Loan Calculator (PITI). (MSN Money also has a mortgage calculator.) I came up with a monthly payment of $1,286.08 given these assumptions:
Mortgage loan amount of $150,000.
30-year fixed mortgage at 6.250%.
$3,750 annual property taxes, $600 annual home insurance.
If you assume 20% down ($37,500), that's a $187,500 home.
Adjusting the rule
The rule is good as a starting point, but you may have circumstances that can work for or against you in terms of how much you can pay each month.
Existing debt could reduce the amount you should spend on housing, because every month a set amount is earmarked for retiring that debt.
If you live in an area with a high cost of living and your budget says you can't afford to spend 25% to 33% of your salary on housing, you'll have to adjust it. (The opposite may also hold true.)
California has student loan payments of about $300 a month that he'll
have for the next 20 years, locked in at a favorable sub-4% rate. It's
not something he's looking to pay off quickly, so it will be with him
for a while. He also has a car payment of a few hundred dollars a month
(I'm assuming the magnitude; he just said he has a car payment), so he
already has a percentage of his take-home page earmarked for servicing
existing debt. This could adjust his housing allocation more toward
25%, rather than 33%.
Analyze your budget and see if you have room to adjust your ranges higher too.
You might find that you're saving 50% of your salary because you live
lean or in a place with a low cost of living. You might be willing to
adjust that housing number higher to own a little more house.
By having a budget, you can make these decisions with concrete data rather than with gut feeling.
only warning I'd offer is that it's far easier to get into debt than it
is to get out of debt. A mortgage stays with you a very long time, so
don't rush into getting a larger one than you think you can comfortably afford.
Other articles of interest at Blueprint for Financial Prosperity:
- Best certificate of deposit rates
- 5 affluent banking credit cards you can't afford
- How to get rid of ants safely
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